Should you buy, hold, or sell? You have to answer that question with another one: Is the asset cheap or expensive?
In this article, I'll help you find out and analyze all of it in three simple fast steps.
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Step #1: Ask Yourself – Is The Asset Cheap Or Expensive?
Prior to 1970, gold was around $200 an ounce. Then when Nixon took us off the gold standard, in 1971, it went up to a thousand dollars. Then, it went down again to about $600.
In the late 1970s, and 1980, it went parabolic, up to almost $2,400 an ounce, if you adjust for inflation.
After this, as many of you may know, Volcker came in and put the brakes on inflation, jacked interest rates up to almost 20%, and gold came crashing down, until we hit a low in about 2000.
At the beginning of 2000 we had a commodities bull market. Gold went all the way up until it peaked out around 2011 or so, because of all the quantitative easing and the Fed expanding its balance sheet.
Everyone was worried about inflation, but it got a little bubbly there, and it came all the way down. After that, gold has been in a bear market kind of consolidation period until this year, 2020.
Insert COVID-19 + the Fed taking its balance sheet up to over $7 trillion.
Now gold does bounce around a little bit, but recently it's gone up and up until now, when it's over $1,900 an ounce.
At an all-time high in nominal terms, but in real terms, it's still not at its all-time high yet.
Now, moving on to Bitcoin, here is a chart going back to 2012.
As you can see, it doesn't do much. A little blip is seen in 2014, when it got over a thousand in 1400, yet, it came back down. But then in 2017, we had the Bitcoin bubble of all time.
Long term I'm bullish on Bitcoin, I like it as a speculation, but I don't care how gung-ho you are about Bitcoin, you have to admit that was a huge bubble.
In 2018 the cryptocurrency went up to $20,000, and then from 2018 to 2019 incomes crashed all the way down to $4,000. In Mid-2019 it went back up to almost $12,000, but it chops around a lot due to lots of volatility.
Next, we had the halving, but then it went down after that. That was kind of a “buying the rumor, sell the fact”, but now we've gone up over $10,000 again.
The U.S. Dollar
Now, about the United States dollar…
Prior to the 1970s, in the sixties, it went up over a hundred on the DXY, as shown in the chart. Keep this chart in mind while I explain its whole dollar journey.
To be clear, the DXY is just a measurement of the dollar against a basket of other currencies, mostly the Euro.
During the 1970s, when we had inflation, it came down to about 85, and think it's interesting the dollar didn't go lower than 85. This fact shows you how strong the dollar was prior to the 1970s.
Also, keep in mind, this is a monthly chart. If we had a weekly or daily, I think it might've gone down lower than that. I know it went down lower than 80 in 2010, 2011.
But, in the 1970s, the dollar went down to about 85 in the DXY, and then Volker, just like I mentioned in the Gold chart, jacked interest rates, which made the dollar extremely strong.
In the early 1980s, it went up two over 130 on the DXY. That's when they came in with The Plaza Accord 1.0. Keep in mind, we could get a 2.0 if Brent Johnson and the dollar milkshake theory is correct.
Right now that theory is having trouble, but that doesn't necessarily mean it won't play out in the end. With The Plaza Accord 1.0, the dollar lost 50% of its value in only two years.
The dollar then bottomed out in the early 1990s, but next to it, the dot.com bubble appeared, and boom! It raised the value of the dollar.
Then, the bust in 2000 came and the dollar went down, just before the GFC, then it's was a flight to safety.
So, during the GFC, the dollar went up, then the Fed came in with all this money printing, bringing it back down to its lows, right around 2010, 2011. Since then though, the dollar has steadily gone up and up.
More recently, the dollar has been in a range between 101 and 96, but as of the last few weeks, it's fallen out of that range down to about 93, where it is until today.
Nonetheless, we have to ask our main question.
Is gold, the U.S. dollar, and Bitcoin cheap or expensive?
First of all, gold is definitely not cheap when you just look at the chart. But, of course, there's a lot more to gold, Bitcoin, and the United States dollar than just three charts.
Let me throw you a quick curveball. I talked about gold being relatively expensive adjusted for inflation, but that's assuming the CPI is correct.
The CPI understates inflation, that means the price of gold in real terms, would be a lot lower, potentially even cheap.
I'm not here to debate the CPI, that's for another moment, but I'll let you think through and come to your own conclusion on where the price of gold should be on this chart and what you actually think the CPI has been since 2000.
Quick Advice: Always Look At A Historical Chart
Looking at a historical chart is what you should do first when deciding if you need to buy, sell, or wait.
Bitcoin doesn't have much history, and that's why you can't really tell if it's cheap. If it's not compared to itself, and it only started in 2012, you could say it's cheap relative to its all-time high, but that was really a bubble.
Bitcoin it's hard to determine, so I'm going to take a pass on Bitcoin. I'll pass on giving an opinion on whether it's cheap or expensive, not whether I'd buy it or not.
Again, that's why I think it's more of a speculation, not necessarily digital gold.
And… Looking at the United States dollar just with our previous chart, it's definitely not expensive.
If anything, it's actually on the lower range, I would call it more cheap than expensive. If we just take into account the USD chart.
Step #2: Headwinds And Tailwinds For Gold, Bitcoin, And The U.S. Dollar
To begin with you have to understand gold and Bitcoin really compete with the dollar on several different levels. What's good for one, is usually bad for the other.
For better understanding take a look at the chart I drew where I will analyze how different factors affect our commodities. On the left side, I made a list for all the tailwinds and headwinds.
So, let's start with the first driver of the assets: The feds BS or balance sheet.
We all know that's gone to infinity and beyond over seven trillion dollars, but it's pulled back recently.
I personally think over the next few years, the Fed's balance sheet will definitely exceed 10 trillion dollars. That's a lot of base money that can be turned into additional money supply in the real economy.
So, that is a huge tailwind for gold and Bitcoin, and a headwind for the dollar.
Now, speaking of the real economy… In money, we have M2 money supply, which lately has been looking very similar to the Fed's balance sheet.
In the chart, you can see it's going straight up, yet, this doesn't necessarily mean there's a causal effect, but it does mean that there's more potential for future inflation.
On that topic, here is a chart of excess reserves in the commercial banking system at 3.2 trillion dollars at an all-time high.
To be more clear, this doesn't necessarily mean there's automatically more money circulating in the real economy. It just means that the balance sheets for the commercial banks have more capacity to lend either now or in the future.
The banking system is responsible for the majority of new money supply in the real economy. They're the transfer mechanism. So a lot of that is based on psychology.
The main takeaway is there is a lot of potential.
There's a lot of dry powder for future inflation. This means another tailwind for gold and Bitcoin, and more headwind for the dollar.
Now, here is the chart of velocity where you can see that it has dropped pretty much as M2 money supply has gone up.
I know Jeff Snyder would say, “George, you can't use those numbers. They're totally bogus.”
I know that's most likely true, but I'm not really looking at precise numbers here. I'm more looking at trends.
To do that, I think we still can use the data from the Fed's website.
Velocity has gone down quite substantially. That means the rate those currency units are circulating in the real economy is getting slower and slower.
Why is this?
Her hypothesis is: Because a lot of this additional money supply is going into fewer bank accounts, the bank accounts of the rich. Since they have a lower propensity to actually spend the money, it doesn't circulate in the economy.
I want to be very clear. This isn't an argument to tax the rich and spread it out to the middle class, and the poor because that's going to create even more problems.
Remember there is no free lunch, but it gives us an explanation of why that velocity is going down.
The slower those currency units move, the more of a tailwind that is for the dollar, and a headwind for gold and Bitcoin.
The US debt, we all know where that's gone, over $26 trillion just on balance sheet and off-balance sheet, the debt is a lot higher. So that's going to be a tailwind to checkmark for gold and Bitcoin, for sure.
I want to point out that a lot of this debt the government is issuing with huge deficits, is being monetized by the fed, meaning they're creating currency units out of thin air bank reserves to buy those treasuries, from the federal government at auction.
I know it happens through a shell game, but the net result is still the same. The base money increases along with the US debt.
The reason this is important to understand is that if the debt was going to 40 trillion dollars, but is being purchased by Americans or even foreigners with their savings of dollars, it would be the same amount of dollars circulating in the system.
But if the Fed is monetizing the debt, that means there's more currency units in the system.
The questions then become:
Do they stay at the fed in the form of bank reserves?
Do they get out into the real economy?
That goes back to the commercial banking system and the amount of excess reserves.
The bottom line is there's more and more potential for future inflation as a result of the debt being monetized.
So, another tailwind for gold and Bitcoin.
I also want to point out that historically negative real interest rates have been very bullish for gold, and very bearish for the dollar.
But… What do I mean by negative real rates?
That means if the rate of inflation exceeds that interest rate, or the fed funds rate, that's a negative real rate. If inflation is running at 10% and if interest rates are at 5%, real rates are negative five.
Although, the nominal rates have a positive 500 basis points.
The main takeaway from step number two, is because there is a lot of base money increasing dramatically that's kind of potential for future inflation. The only thing holding it back is just this velocity.
I like to picture it as a time bomb of inflation that's about to explode and the only reason it hasn't exploded now, is because of the length of its wick, but it's lit.
It's not a matter of if, it's just a matter of when, and how long is its wick.
This example works for the dollar as well. It can have a long wick, it can go up or down, but sooner or later, the fire is going to get into that bomb and Inflation is going to explode.
That's why I think it's safe to conclude that over the long term, five years, 10 years, there will be a lot more tailwind for gold and Bitcoin and a lot more headwind for the dollar.
Step #3: Now… What Should You Do?
What to do about gold…
I can't be too specific because everybody's situation is different.
I can't give you investment advice, but I can tell you what I'm doing with my own portfolio, and what I suggest to my friends and family members.
To start, take a look at the following chart of gold, this time, it's not adjusted for inflation.
This chart is in nominal terms and goes back to 1986, and on the left, it starts with $200 and goes up to $2000.
At the beginning of the chart, it went up a little bit, and then came down in 1990. It bottomed out in 2000, and finally it went straight up.
This chart only goes to 2012 because I wanted to match it up with the one I analyzed before. But in 2012, when it was at the last nominal high, it had gained 350% roughly, since 1986.
Now, of course, the current Gold chart has exceeded that high in nominal terms.
Here's another chart where I compared the Big Mac Index company with the CPI, which goes back to 1986 as well to about 2012, going from 0% up to 180%.
The CPI since 1986 has gone by 110%, but the Big Mac Index has gone up by 173%. I'm not saying the Big Mac Index is perfectly accurate, but I think it's probably more accurate than the CPI.
So, to answer the question: Should you buy gold?
I want to be crystal clear: I don't see gold as an investment. I don't even see it as a speculation. I see it as insuring your purchasing power.
So, if the job of gold is just to keep you rich, and not make you rich…
In other words, the job of gold is just to preserve your purchasing power. It's a store of value. I can safely conclude that at least since 1986, it's been doing a fantastic job of that.
You can buy almost double the Big Macs today, as you could have back in 1986. That's even using the Big Mac Index itself.
The Big Macs have gone up by 173% in nominal dollars, but gold, gone up almost 350%.
The bottom line is: Gold has definitely done its job.
That's why I don't really worry about the price of gold, I don't really ask myself if it's cheap, or if it's expensive, because it serves such a different purpose in my portfolio. I always buy, regardless of price.
What to do about Bitcoin…
Now for Bitcoin, it's more of a speculation. We don't have a lot of history there.
Philosophically, I understand the argument. I love the bullish argument for Bitcoin, because it's more libertarian, it's a decentralized currency. That's what I'm all about.
I think the upside could be a hundred thousand, a million, who knows! Because there's only 21 million Bitcoins that exist, you have a very limited supply.
But because it's a speculation, I'm not going to go into it with more than 1% of my portfolio. So, let's move on to cash.
What to do about the U.S. dollar…
The reason why I currently hold dollars is just to keep dry powder up my sleeve in case an asset comes down in value where I'd want to trade my dollars for the asset.
I know the argument against it right now. Of course, we explained it in step number two, and that the dollar continues to go down in value while you're holding it.
But you have to ask yourself the question:
Relative to what is the dollar going down?
Is it going down relative to consumer goods, or assets that I want to purchase?
I think there's a good probability that dividend-paying stocks that I want to buy with my cash come down in value over the next couple of years, relative to the dry powder, relative to those dollars.
I'm willing to take the risk short term with those T-bills, just rolling them over.
That's where I like to keep my cash and I'm willing to take the inflation risk, to have the optionality, to transition, and rollover into an asset that's getting cheaper and cheaper and cheaper.
Now whether that's going to be real estate, whether it's going to be stocks, who knows, I'm not sure what it is, but I'm willing to take the risk.
What I would do to limit my downside from that inflation standpoint, is to look at interest rates on the yield curve.
I know that the fed can suppress them and do everything. But if you see yields, at the long end of the curve starting to spike up and the fed has to buy more and more of them.
That's when I'd be more hesitant holding dollars and I'd maybe transition into more precious metals, or maybe even Bitcoin. If it becomes a lot less volatile.